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BUILDING A COMPETITIVE AFGHAN CARPET VALUE CHAIN THROUGH INFORMED STRATEGY AND PRODUCTIVE ATTITUDES ROB HENNING, OTF GROUP RHENNING@OTFGROUP.COM DECEMBER.

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Presentation on theme: "BUILDING A COMPETITIVE AFGHAN CARPET VALUE CHAIN THROUGH INFORMED STRATEGY AND PRODUCTIVE ATTITUDES ROB HENNING, OTF GROUP RHENNING@OTFGROUP.COM DECEMBER."— Presentation transcript:

1 BUILDING A COMPETITIVE AFGHAN CARPET VALUE CHAIN THROUGH INFORMED STRATEGY AND PRODUCTIVE ATTITUDES
ROB HENNING, OTF GROUP DECEMBER 14, 2006

2 GLOBAL VALUE CHAIN: AFGHAN CARPETS
Global Enabling Environment National Enabling Environment Local & regional banks, MFIs, hawala Design Transport & logistics, BDS, IT providers, insurance Weavers Wool, dye & chemical providers National Retailers Exporters Int’l Retailers Traders Finishing (Cut & Wash) Int’l Wholesalers 80% of finishing takes place in Pakistan and locally sold carpets are shipped BACK to Afghanistan

3 OTF GROUP 5 STEP STRATEGY FORMULATION PROCESS
Situation Analysis Step 2 Step 3 Step 4 Step 5 Carpet Industry Goals Understand Carpet Buyers’ Needs Articulate Afghan Carpet Market Positioning Develop Action Guidelines Research and Analysis Cluster Mobilization

4 AGENDA MOBILIZATION – THE ROLE OF ATTITUDES RESEARCH, ANALYSIS AND INSIGHTS

5 THE ROLE OF PAKISTAN IN AFGHANISTAN’S CARPET VALUE CHAIN
Building the Afghan value chain depends on capturing more of the value in production and trade that is currently occurring in Pakistan. In an insecure investment climate, the importance of mobility increases. Some elements of the value chain are more mobile than others. Partial financing from Pakistan Wool from Pakistan and Ghazni Production in Afghanistan Designs from Pakistan Sale to US & EU from Pakistan Transportation to foreign markets C&W in Pakistan Mobility: High Simple C&W facility but requires transportation of chemicals. Climate offers some restraints. Mobility: Medium Market demand linkages take time to be develop, though they can be accelerated through aggressive research. Majority has moved from Pakistan over only 3 year period Reliable global transportation links are difficult to develop, but alternatives exist. Mobility: Low Business networks are mobile, but take time to develop. Access to financing can be developed in the near term, but a trusted banking system will take longer. Wool production is increasing and imports can fill current gaps

6 Distribution of Responses (1 to 7scale)
ATTITUDES AND BELIEFS OF AFGHANISTAN’S CARPET SECTOR: AREAS OF DIVERGENCE There are mixed feelings about the importance of Pakistani partners with regard to the future of the Afghan carpet sector Distribution of Responses (1 to 7scale) Mean Survey Question Agree (5-7) Disagree (1-3) Neutral (4) I cannot imagine replacing the role played by Pakistani carpet traders in the next 3-5 years The current success of my business is dependant on the role played by Pakistani carpet traders; for now I cannot do without them

7 Imam at Domotex – Germany 2006 Haji Zabibullah at work
ATTITUDES AND BELIEFS OF AFGHANISTAN’S CARPET SECTOR: NEW VS. OLD WAY Imam at Domotex – Germany 2006 Haji Zabibullah at work in Andkhoy Photos by Aref Adamali, OTF Group.

8 AGENDA MOBILIZATION – THE ROLE OF ATTITUDES RESEARCH, ANALYSIS AND INSIGHTS

9 INTERNATIONAL CARPET MARKET: TOP IMPORTING COUNTRIES
The US and Germany are by far the largest buyers, with the US passing Germany in Shrinking between , the carpet market is rebounding towards its peak in 1999. Value of Imports: Global Total and Top-5 Importers, (US$, millions) The largest carpet market in 1998, Germany has rapidly declined, falling to half its 1998 level in The market has turned around since, growing at 7% between ; however, Germany is no longer likely to be as dominant a buyer as it once was. The US market has been the only market to maintain a positive growth rate, averaging 6% between (driven mainly by high growth pre-2001). However, like other countries, the US market also took a downturn, though not as dramatically. The market picked up to grow at 3% between Despite a strong housing market, building up to a 21 year housing starts record in Jan (NAHB), carpet sales have declined. However, most traders expect 2005 to be a stronger year. Source: USAID Trade Map

10 INTERNATIONAL CARPET MARKET: THE US MARKET
India has dominated US carpet imports for the past 10 years, doubling its sales. China has since 2000 lost market share to Iran. Though still a comparatively small player, Nepal experienced impressive growth. Value of US Imports from Top 5 Supplying Countries, (US$, millions) Growth, IND 3% IRN PAK 13% CHN -17% NPL ALL 4% 534 530 509 482 487 488 422 372 288 241 After years of double digit growth to a peak in 2000, US imports stagnated with the to the post-dotcom recession. However, the market is showing signs of strong recovery, approaching its 2000 peak in looks to be a strong year, with total first quarter imports 15% higher than the same period in 2005. Unlike India and China, Pakistan was not as adversely affected by Iran’s re-entry to the US. This implies that its exports to the US – both traditional Afghan and Chob Rung carpets – cater to a different niche from pure Persian and Indo/Sino-Persian carpets. It has also grown well in Takeaway: Clearly an attractive market, the US is also very competitive. Afghanistan should avoid entering price sensitive segments that Iran, India and China serve. Growth Stagnation Revival Source: US International Trade Commission

11 INTERNATIONAL CARPET MARKET: AVOIDING THE “MOVE TO THE MIDDLE”
“We’re getting competition that we didn’t get before from machine mades.” - -US Importer Major manufacturers and distributors are increasingly turning towards becoming ‘one-stop shops’, stocking both tradition/oriental and modern designs, as well as machine-made and handmade carpets. As machine weaving technologies improve, there is decreasing differentiation in the market between mid-range hand-knotted and good quality machine-made carpets. Example of machine-made oriental carpet “And what about hand-knotted rugs versus machine-made rugs? The fact is, there are rugs of extraordinary quality made both ways, and there are rugs of highly inferior quality made both ways … While a 6' by 9' rug can vary in price from $59 to $10,000 or even more, the general rule of thumb is that you get what you pay for. … And even among the very highest-priced, highest-quality handmade rugs in the world, most Karastan rugs can hold their own in terms of beauty and luxury feel.” – Karastan, Top 5 carpet producer in US. While avoiding direct competition with China, India and Iran, Afghanistan will have to also differentiate its products from machine made carpets, against which it cannot compete on cost or certain elements of quality. “A major trend in product construction has been the melding of handmade and machine-made sensibilities. In the major middle-market price points of $600 to $1,500 for 6' x 9' rugs, the method of production is now less important than the way the product is styled and colored … Price points for handknotted, hand-tufted and power-loomed products regularly intersect.” - National Floor Trends Magazine, March 2001 6’ X 9’ rug: Machine made - $400 Hand tufted - $600 Handmade (India) - $1000. (NFT: Example of handmade oriental carpet

12 INTERNATIONAL CARPET MARKET: CHANGING TRENDS
Styles and colors are also changing more rapidly. While niches for traditional carpets are affected less by this, the opportunities for growth and volume may lie in serving ‘trendy’ – but more volatile – markets. The market for high quality, traditional Afghan carpets is more stable. However, it has been marred by a limited range of designs and colors, as well as poor quality There may be good growth opportunities around ‘soft contemporary’ designs, such as Nepali/Tibetan carpets (which experienced over 250% import growth into the US between 1995 and 2004). It is unlikely that the Afghan carpets sector will be able to rely fully on the traditional carpet niche. Serving larger markets will require considerable customer understanding and the ability to forecast and respond to rapidly changing trends in design and colors. (such as the use of non-fast chemical dyes and unevenness of carpet and borders). Chob Rung designs – also referred to tea washed/stained – have done well over the past 10 years, but may be nearing the end of their cycle. Kabul-based producers of Chob Rung carpets surveyed by OTF reported an average decline in sales of 25% over the past few years. Examples of ‘soft contemporary’ carpets Source: OTF research; 1. National Floor Trends Magazine, April 2002.

13 UNDERSTANDING BUYER NEEDS: PRODUCT ATTRIBUTES, OVERVIEW
Color, design, type of fiber, and price are the most important product attributes in both the USA and Germany. Country of origin, quality guarantees, environmental and labor issues matter the least. Most important product attributes Ranked according to average of both countries (1= Not important; 5 = Very important) Respondent rating (scale 1-5) Product certification quotes “About certification: museum, government, etc. certification of an Oriental rug would be regarded as a colossal joke by anyone in the trade … we all know, you can get a rug certified … for a bit of baksheesh. Nobody believes what rug sellers say, anyhow...” “… Certain retail buyers care about … child labor … we try, but that does not in any way eliminate child labor. At least, we can say we are trying. Work on that bit, and don't fool about with quality certifications.” Despite commonality in many areas (highlighted in diagram), there are some important differences between the US and German markets: Size is the 3rd most important attribute in the US, but 9th in Germany. Quality of weave ranks 5th in Germany, but 9th in the US. Durability ranks 6th in Germany, but 9th in the US. It is common in the US for identical carpets to be produced in many different sizes, referred to as ‘programmed carpets.’ They are therefore sold not as unique products, but as standardized interiors items. Germany’s emphasis on weave and uniformity, as opposed to size, indicates that oriental carpets are still purchased as original artisanal products, valued for the quality of the workmanship. However, this is changing: “Carpets are becoming more of a fashion good and are not regarded as a traditional good anymore.” –Wholesaler, Germany The product’s aesthetics, quality of inputs, and value should form the foundations of a national carpet brand. Brand attributes Not relevant Highly relevant

14 UNDERSTANDING BUYER NEEDS: PRODUCT ATTRIBUTES, COLOR & DESIGN
Earth or natural tones are popular in both the US and Germany, as are contemporary designs and simple floral patterns. Color attributes (1 = Not important; 5 = Very important) US market Product implications: Kazakhs and Chobis in natural dyes would do well. There is an untapped opportunity in earthy contemporary designs, such as Gabbehs. Intricate Kashmiri-type carpets are unlikely to be popular. German market Chobis in natural dyes would do well. There is an untapped opportunity in contemporary carpets, in both bright colors and earth tones. Commonality Divergence Respondent rating (scale 1-5) Both markets rate intricate floral carpets low, while differing considerably in their rating of bright colors. Respondents rate earth/natural tones highly. Bright colors come in last. Tribal designs and both contemporary and simple florals are highly rated, while intricate floral designs do badly. Afghanistan needs to maintain its production of good quality Chob Rung carpets, while developing capacity to enter the contemporary design segment through increased market learning. Respondents rate earth/natural tones highly, like the US. But in contrast to the US, bright colors are by far the most popular. Both contemporary and simple florals are highly rated, while intricate floral designs do badly. Tribal designs come somewhere in the middle. Design attributes (1 = Not important; 5 = Very important) Respondent rating (scale 1-5)

15 UNDERSTANDING BUYER NEEDS: OPERATIONS, BUYER REQUIREMENTS
Supplier reliability and ease of transaction are what matter most to buyers. Suppliers need not concern themselves with elements such as marketing, inventory or insurance management. Operational priorities Ranked according to average of both countries (1= Not important; 5 = Very important) What matters to buyers “Customer Quotes” “Reliability of producer is very important – [a] long-term trustworthy relationship is key.” – Wholesaler/Retailer, Germany “Quality of materials, honesty and reliability of supplier.” – Retailer, USA “The trustworthiness of the supplier and his understanding of the US market in terms of colors and designs.” – Wholesaler, USA “Good quality and design; reliability of the producer; adequate realization of [a] given order.” – Wholesaler, Germany “Protection of a contractor's designs [is important]. If I develop a design, I don't want it pirated … which is common amongst Afghan weavers.” – Wholesaler/Retailer, USA There is no substitute for being an honest, reliable producer. However, much is also dependent on the enabling environment, in terms of transportation, banking and communication facilities.

16 UNDERSTANDING BUYER NEEDS: OPERATIONS, SOURCING CHANNELS
Almost half of US buyers commission their carpets. However, Americans are also less willing to travel to Afghanistan to source carpets than German buyers. Willingness to travel to Afghanistan to source carpets About 70% of respondents source their carpets direct from producers, with the balance buying from wholesalers in the supplier country. Trade magazines and on-line sources are rated among the most common source of new carpet supplier contacts. Trade shows do not feature highly. Commissioning versus buying ready-made Reluctance of American buyers to travel to Afghanistan is problematic – particularly because they commission almost half of their carpets. Building their comfort with visiting Afghanistan will be key to capturing their business. There is considerable reluctance by American buyers to even entertain the idea of sourcing carpets directly from Afghanistan. In contrast, over 60% of buyers from Germany say that they are willing to travel to Afghanistan to buy carpets.

17 MARKET POSITIONING: BUYER PERCEPTIONS OF SUPPLIER COUNTRIES
India and Nepal enjoy strong reputations among buyers, with Iran coming in third. However, there are substantial differences in perception between markets. Which country comes closest to being your ideal carpet supplier? (Percent of total respondents in each market) Nepal is rated very highly in Germany, but comes in 5th out of 8 in the US. There is a substantial gap between India’s reputation and the second strongest, China, in the US. Afghanistan rates poorly as a supplier. The challenge lies in addressing this, while an opportunity exits in that Afghanistan is still a little known exporter. Afghanistan rates very low. This may in part be accounted for by limited buyer familiarity with Afghanistan (due to limited exports in comparison to other major producers).1 1. OTF discussion with buyers in the USA revealed limited knowledge of Afghan carpet production, other than traditional varieties from pre-conflict era.

18 MARKET POSITIONING: INDIAN CARPET CLUSTER
Different cities have different areas of specialization. Bhadoi is the main carpet producing center, producing the widest range of carpets, with the largest production facilities. Kashmir “For your exquisite silk carpets.” 1 Intricate silk carpets. Jaipur* “City of innovative styles. Medium and high qualities.” Hand-knotted carpets. Panipat* “For your contemporary fashion oriented tufted.” Almost exclusively tufted carpets, both traditional and contemporary designs. Agra “City of natural vegetable dyes for recreation of your antique pieces” Majority of production is hand-knotted. Bhadoi* “Great … for your cheaper yet fashion oriented hand-tufted, Indo-Tibetan and great hand-knotted of low & high qualities.” A ‘cluster’ in the truest sense, with over 80% of the town’s activities somehow related to carpets.1 Little made-to-order production (due to long turn-around time). Supply constraints reported. Approximately 10-15% are from high-twist, hand-spun wool, using what is referred to as ‘Ghazni wool’. Considered to produce lower knot count products. * Research and site visits conducted by OTF in this production center (and surrounding area); June Estimate by cluster members. 1. Quotations from web site of the Carpet Export Promotion Council, 2. Some producers claimed to use actual Ghazni wool; others said it was unlikely to be from Ghazni.

19 MARKET POSITIONING: INDIAN CARPET VALUE CHAIN, TRANSFORMING TRADITIONAL DESIGN
India does not restrict itself to traditionally Indian designs, but is quick to adopt and adapt designs from different parts of the world, creating interesting and potentially saleable products in the process. The top carpet is an older carpet – a classic Turkmen-Afghan carpet in traditional colors. Below is a new Turkmen-Afghan design, woven in India, with the use of more contemporary colors.1 A traditionally Afghan motif (above), often used as a secondary ‘gul’ on Suleman designs, is incorporated into a flat-weave kilim in more contemporary colors (right). Note on carpet on left: 1. This is Kilim 2. Different use of colors 3. Secondary gul used inside primary fil pai. Producers recently noticed that there is a good market for ‘antique-look’ carpets – Chob rungs and Zigglers. They are therefore now producing them, using a high twist Ghazni wool and a natural dye effect. 1. Quotation by US carpet wholesaler/retailer: “[Afghanistan requires] more emphasis on contemporary designs and colors geared toward fashion. Red and blue are losing ground.”

20 MARKET POSITIONING: AFGHANISTAN’S POTENTIAL TRAJECTORY, AVOIDING THE “MOVE TO THE MIDDLE”
India is moving to the middle of the market, competing on a mix of design innovation & cost. Afghanistan is unlikely able to compete against India in these two areas in the near term. At the same time, China may be redrawing the cost axis of the productivity frontier. Excellent Cost Poor Differentiation Intense competition in the low-cost, low differentiation quadrant makes it unattractive India China Afghanistan Child labor: Became big issue for India in 1995, and now children are seldom used (though some may be in Jaipur). This is particularly true for tufting, which requires an adult to work the tool. Brand: Indians stressed Iran’s brand as its key advantage (not the quality of Persian carpets). In this regard, India has an edge over China (more exotic). Institutional capacity: All Indian carpets go out with specifications on inputs, etc. Afghanistan cannot succeed in the near term with a cost-focused strategy. This requires it focus on differentiation as the basis of its competitive position. The Indian carpet industry is a dynamic and innovative competitor – many years ahead of Afghanistan. Competition is also further increasing with the introduction of good machine-made carpets from China, which may be pushing out the productivity frontier. The weak business environment in Afghanistan is less supportive of efficient production than many other countries, therefore cannot support a low cost strategy.1 This forces the strategic choice that the Afghan carpet industry can make, precluding businesses from pursuing a low-cost strategy as the base of their competitive advantage. 1. For example, according to the World Bank, Pakistan has ten times more road coverage than Afghanistan, and India has 30 times that number.

21 ACTION AND INVESTMENT PLAN: REQUIRED PRODUCTION TO SERVE NEW CUSTOMERS
Investment efforts will focus on production for direct to end-market sales. The latter will require investing in a local cut and wash sector, as well as greater spending on design and marketing. TOTAL NPV1 of industry cash flow $84.8 M Total investment $83.8 M Share of total export value ($, millions) 368 334 Integrated production facility 5% volume growth NPV1 of IPV cashflow $31.5 M Investment $48.2 M Price assumption2 2 times 302 273 245 219 Export value ($, millions) 194 This will come from a combination of new capacity of IPFs and redirecting current DPN capacity towards end-markets. Note: DPN models require less investment by business owners because looms are housed by weavers. Business owners in effect pass down investment costs (land and buildings) to workers, despite them being less able to bear such costs. 174 Distributed production network 10% volume ‘conversion’ NPV1 of upgraded DPN cashflow $45.6 M Investment $35.6 M Price assumption2 1.5 times 158 146 1. NPV discount rate of 20%. Total NPV includes all production; separate DPN NPV is only for cashflow of upgraded capacity. 2. Multiple of current export sale price to regional buyers.

22 THANK YOU. Please visit www. microlinks
THANK YOU! Please visit for seminar presentations and papers ROB HENNING December 14, 2006

23 Annex: Complete 5 Step Process
To be distributed as a handout

24 OTF GROUP 5 STEP STRATEGY FORMULATION PROCESS
Situation Analysis Carpet Industry Goals Understand Carpet Buyers’ Needs Articulate Afghan Carpet Market Positioning Develop Action Guidelines Export value estimated at >$140 M Market: Increasingly competitive with top 5 buyers accounting for 70% of demand; prices moving downward Domestic bottlenecks: Cutting and washing, access to finance, transportation, market knowledge and linkage Differentiation: Important to build strong brand based on quality products Grow industry export value at 11% annually; total export value of >$350 M by 2015 Grow volume 5% >80% of exports cut and washed in Afghanistan and sold direct to end-markets by 2015 Develop new products Increase productivity and raise wages Increase local wool use from 33% to 65% Brand identity: product’s aesthetics, quality of inputs, and value Size matters more in the US; weave and price more in Germany Afghanistan is well positioned with hand-knotted, naturally dyed carpets, such as Chob Rung carpets Contemporary design market is an untapped opportunity Afghanistan should pursue a differentiation-based strategy This will require concerted focus on developing a quality product (design, inputs, value) and fostering reliable, high-trust relations with buyers A strong brand will be required to support this differentiation; labor issues will likely be important Afghanistan will likely pursue two production models: an Integrated Production Facility (IPF) and a Distributed Production Network (DPN) Total NPV of 10 year industry cash flow $84.8 M; required investment of $83.8 M Public financing will be required to support market access, design diversification, and maintenance of industry leadership institutions Analytical Agenda Form and engage private-public industry leadership group, the Afghanistan Carpet Committee Agree on a working schedule with Carpet Committee Identify core industry members of groups as well as subject matter experts Build sense of shared vision within industry Initiate issue-specific working groups Form a research plan based on initial hypotheses Leverage OTF Insight to conduct international carpet market research Use competitor findings to stimulate discussion around priority areas within industry group Involve all subject matter experts in clarifying potential issues Engage Afghanistan Carpet Committee in process of strategy vetting, buy-in and implementation Lead a campaign to inform all stakeholders of strategy implication Institutional Process


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